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Ezrati’s Economic Outlook: More Drama in Europe

As the continent rejects austerity, proposals for structural reform are promising but vague.

The drama never ends. The past few weeks have seen another sudden change in the eurozone’s political-economic complexion. Four or five weeks ago, the continent seemed to have established a pretty firm consensus for fiscal austerity. Since then, the government in the Netherlands has fallen over the question of austerity, and elections in France and Greece have all but quashed any such conviction. Street protests in Athens, Madrid and elsewhere have also spoken to the breadth of anti-austerity feeling.

The original emphasis on austerity was always a German stance. Since Germany, Europe’s largest economy and also arguably its healthiest, was destined to carry the burden in any bailout, Merkel’s demand for budget control is certainly understandable. The Danes, the Dutch, the French—then under President Nicolas Sarkozy—and others signed on, either because they agreed with the Germans or because they decided that the appearance of unity was important. The accord, signed late last year, fell short of the “fiscal union” of which some spoke—effectively a eurozone-wide approach to budgeting—but it sought strict rules on the relative size of each member’s deficits and its outstanding public debt. The austerity seekers even agreed to impose fines on nations that violated the rules.

If this agreement ever captured a consensus, it did not last long. The election in France of the Socialist presidential candidate, Francois Hollande, showed a thorough rejection of austerity. Indeed, Hollande’s campaign to unseat Sarkozy rested on demands for an easier, pro-growth fiscal policy, especially on the spending side of the budget. The Greek elections turned out the government that had negotiated the rescue and the connected austerity regime and put in its place not just an anti-austerity plurality, but a significant number of euro-skeptic politicians as well. Regional elections in Germany rejected Merkel and austerity, as have recent regional elections in Italy. Not too long before the French, Greek and other elections, governments in the Netherlands and Slovakia fell over the issue of austerity. Still earlier, the Italian government of Silvio Berlusconi fell over questions about austerity, and though Berlusconi’s technocratic successor, Mario Monti, has felt a need to placate the Germans, he has nonetheless questioned the exclusive focus on austerity that characterizes the German approach.

The European pushback against the German plan is far from uniform. At base, it comes in two varieties. One is a simple rejection of the pain implicit in fiscal discipline, especially spending cuts. This straightforward motivation certainly animates the street protestors, the socialists in Slovakia, Mr. Hollande’s supporters and many who rejected the Netherlands’ pro-austerity governments under Mark Rutte. But there is also a more subtle and nuanced reaction, an approach that recognizes a need for austerity but sees danger in the German pact’s single-mindedness and would also pursue growth through what are popularly referred to as “structural reforms.” Signore Monti in Italy seems to be in this camp. The International Monetary Fund under France’s Christine Lagarde and, in a more guarded way, European Central Bank President Mario Draghi also seem to see matters in this way.

The first variety of pushback, though understandable, is nonsensical. A straightforward choice between austere or expansive budgets in the current context is simply a decision on how nations would commit economic suicide. On the one side, the German approach carries the huge risk of creating a vicious cycle in which austerity actually enlarges deficits by reducing tax revenues and increasing spending for social services. Because such enlarged deficits would only induce greater levels of austerity, this approach could set off a spiral of economic and financial decline that would prevent these governments from ever reaching solvency.

A decision simply to ignore budget imbalances and spend would lead to disaster as well, by extending the policies that brought these economies to their present budget impasses. Such a path would just about ensure default in the not too distant future. The only hope for Europe, then, lies in the second, more nuanced approach that addresses deficits with budget restraint but would also find alternative ways to pursue growth.

The exact nature of such growth measures is hard to pin down. Both Monti and Draghi speak of balancing austerity with changes that would make Europe “more competitive,” but beyond that they only hint at specifics. The most substance comes from Jörg Asmussen, the German member of the ECB executive board, who has tried to flesh out this approach by pointing to Germany’s 2010 reforms. These created economic flexibility and growth by easing job dismissal protections, lowering bureaucratic hurdles to new business creation, setting higher retirement ages and eliminating other regulations that heighten non-wage labor costs. Others have mentioned government asset sales and privatizations of some government services. But beyond this, much remains vague. Monti has confused the issue further by calling for more infrastructure spending and so sounding like those who would ignore budget discipline altogether and spend. He could, of course, square that call with overall fiscal restraint by also insisting on a thorough review of budget priorities. But he has left matters unclear.

Given such a lack of specificity, this second, otherwise more promising structural approach seems like a slender reed on which to lean. But even if the ideas behind this approach need development, it remains the only sane response to Europe’s situation. The alternatives, whether austerity alone or a wholesale rejection of austerity, promise only disaster of one kind or another. The risks and opportunities lie in whether this new crop of European leaders is up to the task.

About the Author

Milton Ezrati

Milton Ezrati is senior economist and market strategist for Lord Abbett & Co. and an affiliate of the Center for the Study of Human Capital and Economic Growth at the State University of New York at Buffalo. His latest book, Thirty Tomorrows, linking aging demographics and globalization, will appear next summer from Thomas Dunne Books of St. Martin’s Press. See more of his articles about the economy here.

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